Almost eight years following the enactment of the
Gramm-Leach-Bliley Act of 1999 (GLBA), (1) Regulation R was jointly
adopted by the Securities and Exchange Commission (SEC) and the Board of
Governors of the Federal Reserve System (FRB) in September of 2007 to
implement provisions of GLBA governing the regulatory status of banks
engaged in securities activities. (2) Prior to passage of GLBA, U.S.
banks (including U.S. branches and agencies of non-U.S. banks) (3)
enjoyed blanket exception from the definitions of "broker" and
"dealer" under the Securities Exchange Act of 1934 (the
Exchange Act). (4) GLBA replaced this blanket exception for banks with
eleven functional exceptions from the definition of broker and four from
the definition of dealer--these functional exceptions are largely based
on the capacity in which the bank acts or the type of security involved
in the bank's activity. Securities activities of a bank failing
outside these functional exceptions need to be "pushed out" of
the bank to a registered broker-dealer subject to regulation by the SEC.
Thus, the functional exceptions are often referred to as the push-out
exceptions.

Although the SEC adopted final rules to implement the dealer
push-out exceptions five years ago, (5) final rules to implement the
broker push-out exceptions were not promulgated until September of 2007
due to substantial adverse reactions to previous proposals from the
banking industry, banking regulators, and key members of Congress. (6)

Some of the core criticisms of the SEC's prior regulatory
proposals regarding the push-out exceptions were that these proposals
would unnecessarily intrude on long-established bank securities
activities, disrupt existing and prospective bank customer relationships
and operations, and increase compliance costs for banks active in trust,
custody, and other securities-related lines of business that Congress
intended to exclude under GLBA.

President Bush signed into law on October 13, 2006, the Financial
Services Regulatory Relief Act of 2006 (the Regulatory Relief Act) (7)
to break the regulatory impasse created by the SEC's repeated yet
unsuccessful efforts to adopt broker push-out rules under GLBA and to
assure active banking regulatory agency participation in the SEC
rulemaking process. Section 101 of the Regulatory Relief Act effectively
set aside the SEC's then outstanding rules relating to the broker
push-out exceptions and required the SEC and the FRB, after consulting
with the other federal bank regulatory agencies, to adopt joint rules to
implement the broker push-out exceptions. The Regulatory Relief Act
required proposed rules to be issued within 180 days. The SEC and the
FRB issued a release proposing Regulation R in December 2006. (8)

The provisions of proposed Regulation R were a significant
improvement over the rules previously proposed, and to a large extent
addressed the concerns of the banking industry and the federal banking
agencies. Final Regulation R substantially adopts the December 2006
proposal. (9) Regulation R defines key terms in some of the broker
push-out exceptions for banks and provides certain related exemptions.

Although the regulation is now effective, (10) Rule 781 of
Regulation R exempts banks from complying with the regulation during a
transitional period that will last until the first day of a bank's
fiscal year commencing after September 30, 2008, which gives banks time
to conform their activities to the regulation and to request
clarifications through formal or informal rulemaking or interpretive
actions.

This Article highlights the key provisions of Regulation R,
including the ongoing attempts to resolve those issues that created the
greatest controversy in the SEC's prior rulemaking attempts. This
Article also discusses transition issues, next steps, changes to the
dealer rules, and complementary amendments to Exchange Act Rule 15a-6.

Regulation R also provides a number of conditional exemptions to
accommodate other bank securities activities including certain mutual
fund, insurance and employee benefit plan transactions, certain
securities lending activities, and transactions in "eligible
securities" involving non-U.S. counterparties conducted pursuant to
Regulation S. Importantly, Rule 780 of Regulation R provides banks with
an exemption from possible third-party rescission rights under Section
29 of the Exchange Act pursuant to contracts entered into by such banks
in violation of the Exchange Act's broker-dealer registration
requirements. (16) However, this exemption expires on March 31, 2009,
after which date a permanent exemption from Section 29 of the Exchange
Act will continue to be available with respect to any contracts entered
into by a bank if, at the time the contract was entered into, such bank
acted in good faith and had reasonable policies and procedures in place
to comply with Regulation R and any violation of the registration
requirements did not result in any significant harm, financial loss, or
cost to the person seeking to void the contract.

A. Networking Exception

Under the networking exception, a bank may refer a bank customer to
an affiliated or third-party broker-dealer in return for a share of the
commissions earned from the customer's securities account without
being deemed a "broker" under the Exchange Act, so long as
certain conditions are met. Regulation R contains complex provisions
concerning compensation of the bank employee who makes such a referral.
Rule 700 defines the type and limit of compensation that a bank employee
may receive for making a customer referral under the statutory exception
(i.e., nominal one-time cash fee of a fixed dollar amount), as well as
the conditions under which bank employee bonus plans will be exempt from
the restrictions on payment of referral fees to bank employees. In
addition, exemptive Rule 701 allows payment of higher-than-nominal fees
to bank employees for referral of high net worth and institutional
customers, subject to certain conditions.

1. Nominal Fees

GLBA provides that any bank employee who is not also an associated
person of a registered broker-dealer generally may not receive
"incentive compensation" for making referrals, other than a
"nominal one-time cash fee of a fixed dollar amount." (17) The
Adopting Release notes that "Congress included this general
prohibition on, and limited exception to, incentive compensation to
reduce concerns regarding the securities sales practices of unregistered
bank employees." (18)

Rule 700(c)(1) defines "nominal one-time cash fee of a fixed
dollar amount" to mean any amount paid only once for a referral not
exceeding the greatest of: (1) $25 (adjusted for inflation every five
years beginning on April 1, 2012); (2) twice the average hourly wage for
the employee's "job family" (such as loan officers); (3)
1/1000th of the average annual base salary for the employee's job
family; (4) twice the employee's actual base hourly wage; or (5)
1/1000th of the employee's actual annual base salary. The last of
these criteria was added to the final rule in response to comments after
the proposing release was published. The fees for securities referrals
under the rules can only be paid in cash, but the final rules clarify
that banks may use a points system to track nominal cash referral fees
payable to an employee so long as the points translate into a cash fee
and the amount of cash ultimately received for a referral does not vary
based on the number or type of securities referrals made by the
employee. (19) These fees cannot be contingent upon an actual
transaction occurring. (20)

2. Bonus Plans

To accommodate banks' bonus plans, the definition of
"incentive compensation" excludes discretionary bonuses based
on multiple factors or variables. In particular, Rule 700(b)(1) provides
that a bonus is excluded from incentive compensation if it is paid on a
discretionary basis and based on multiple factors or variables, provided
that: (i) those factors or variables include multiple, significant
factors or variables that are not related to securities transactions at
a broker-dealer; (ii) a referral made by the employee receiving the
bonus is not a factor or variable in determining the employee's
compensation; and (iii) the employee's compensation is not
determined by reference to referrals made by other persons (e.g., the
employee's subordinates). Such bonus programs may take into account
the full range of banking, securities or other business that customers
bring to the bank and its broker-dealer affiliate through the efforts of
an employee.

In addition, Regulation R includes a safe harbor intended to allow
banks to avoid having to analyze whether a particular bonus program
meets the multiple factors and variables test described above. Rule
700(b)(2) allows banks to pay bonuses based on overall profitability or
revenue of: (i) the bank, either on a standalone or consolidated basis;
(ii) any affiliate of the bank (other than a broker-dealer) or any
operating unit of the bank or an affiliate (again, other than a
broker-dealer), provided that the affiliate or operating unit does not
over time predominantly engage in the business of making referrals to a
broker-dealer; or (iii) a broker-dealer. If a bonus is based on the
overall profitability of a broker-dealer, however, it is further limited
in that the profitability can only be one of multiple factors or
variables with the same conditions as described above under Rule
700(b)(1). (21)

3. Exemption for Referrals of High Net Worth and Institutional
Customers

Rule 701 introduces a new exemption that allows banks to pay
contingent, higher-than-nominal fees for referrals of high net worth and
institutional customers. Rule 701(d)(1) defines "high net
worth" customers as individuals (or couples) with $5 million or
more of net worth excluding their primary residence and associated
liabilities. The definition also includes any revocable, inter vivos or
living trust if the settlor thereof is a natural person who, either
individually or jointly with his or her spouse, meets the $5 million net
worth test. (22) Rule 701(d)(2) defines "institutional
customers" as entities with $10 million in investments, or $20
million in revenues (or $15 million in revenues if the customer is
referred for investment banking services). Because this rule does not
limit the fees to nominal amounts, the exemption is subject to several
conditions intended to address the SEC's concerns about
unregistered bank employees having a salesman's stake in securities
transactions. The bank and the networking broker-dealer are required by
Rule 701 to enter into a written agreement that includes provisions
addressing these conditions of the exemption. (23))

First, the rule imposes an affirmative obligation on banks and
networking broker-dealers to evaluate a customer's eligibility as a
high net worth or institutional customer. (24) Banks must have a
"reasonable basis to believe" that a customer is high net
worth customer at or before the time that a customer is referred to the
broker-dealer or that a customer is an institutional customer before a
referral fee is paid to a bank employee. (25)

Second, Rule 701(d)(4) places limits on the types, but not the
amount, of referral fees that bank employees may receive. Under this
provision, bank employees may receive a fixed percentage of the revenue
received by the broker-dealer for providing investment banking services
to the customer. (26) In addition, bank employees may receive fixed
referral fees or referral fees that are based upon a fixed formula so
long as the formula does not permit the amount of the fee to vary based
on the revenue generated by, or the profitability of a transaction, the
price or volume of any securities transactions effected for the
customer, the identity of any securities purchased or sold for the
customer, or the number of referrals made by the employee. (27)

Third, if the payment of a referral fee is contingent upon the
completion of a transaction, then the broker-dealer must determine,
prior to effecting a securities transaction, that the transaction is
suitable for the customer pursuant to the standards that are applicable
to recommendations made by the broker-dealer under existing
self-regulatory organization rules. (28) If payment of a referral fee is
not contingent on completion of a transaction, the broker-dealer must
either: (a) determine that the customer is sophisticated and has the
ability to make an independent assessment of the risks associated with
the transaction; or (b) assess the suitability of the transaction
requested by the customer at the time of the referral. (29) In any
event, the broker-dealer must notify the customer (but not the bank) if
it determines that the customer or the requested transaction does not
satisfy the suitability or sophistication requirements set forth above.

Fourth, a referring employee: (1) must not be qualified, or
required to be qualified, with a self-regulatory organization; (30) (2)
must not be statutorily disqualified from associating with a
broker-dealer under Section 3(a)(39) of the Exchange Act (except under
paragraph (E) of that section); (31) (3) must be engaged predominantly
in banking activities; and (4) must encounter the referred customer in
the normal course of his or her duties. (32)

Fifth, the bank must make certain disclosures to a customer that
its employee referred under this exemption. A bank has two options under
Rule 701(a)(2) for disclosing referral fee arrangements to a high net
worth or institutional customer. Under the first option, the bank may
elect to provide the high net worth or institutional customer the
disclosure in writing prior to or at the time of the referral. (33)
Under the second option, the bank may provide the disclosure to the
customer orally prior to or at the time of the referral. However, if the
bank provides the customer the required disclosures only orally, then
either: (i) the bank must provide the disclosure to the customer in
writing within three business days of the date of the referral; or (ii)
the broker-dealer must be obligated, under the terms of its written
agreement with the bank, to provide the disclosures in writing to the
customer. (34)

4. Observations About the Networking Exception Under Regulation R

Regulation R provides banks with welcome flexibility in structuring
employee referral and bonus arrangements under the networking exception.
In particular, the accommodation of contingent, higher-than-nominal fees
for high net worth and institutional business is an important
acknowledgment that certain types of compensation arrangements present
lower levels of investor protection concern and therefore should be
allowed. However, the new rules still will not be fully harmonious with
many banks' current incentive-based compensation programs,
including bonus and rewards programs, that are designed to encourage
overall relationship building. Therefore, aspects of such programs that
reward bank employees for the generation, directly or indirectly, of
actual securities business or revenues may have to be modified.
Interestingly, the networking compensation rules do not address, and
therefore would not apply to, incentive compensation arrangements
between broker-dealer firms and banks under which the bank receives
organization-level incentive compensation, provided that it does not
share this compensation with its employees.

B. Trust and Fiduciary Activities Exception

Under the trust and fiduciary activities exception, a bank may
effect securities transactions for its trust and fiduciary customers
without being deemed a "broker" if it is "chiefly
compensated" for these transactions by "relationship
compensation." (35) The purpose of this test is to ensure that
banks are not principally compensated for these securities transactions
by per-transaction fees. A bank may not publicly solicit brokerage
business under this exception other than in conjunction with advertising
its trust or fiduciary services. (36)

"Relationship compensation" includes administration fees,
annual fees, fees based on a percentage of assets under management, flat
or capped per order processing fees that do not exceed the bank's
cost for executing the transactions, and any combination of such fees.
(37) More specifically, examples of relationship compensation include
fees paid by investment companies (such as "12b-1" fees), fees
charged in connection with securities borrowing and lending transactions
for a trust or fiduciary account, fees separately charged for providing
custody services to a fiduciary account, and fees based on the
performance of a trust or fiduciary account. (38)

A bank may use one of two distinct methods to determine whether it
is chiefly compensated by relationship compensation attributable to its
trust and fiduciary business. Under Rule 721, a bank may conduct an
account-by-account review using a two-year rolling average comparison of
the fees from the account to determine whether more than fifty percent
of the compensation associated with each account was permissible
relationship compensation. Alternatively, under Rule 722, a bank may
compare relationship compensation to total aggregate trust activities
compensation on a bank-wide basis using a two-year rolling average to
determine whether at least seventy percent of the bank's
compensation from trust-related brokerage activities was relationship
compensation.

Under either method, banks may exclude from the relationship
compensation calculation fees from certain special types of accounts,
including accounts held for fewer than three months during a relevant
year under Rule 723(a) and accounts acquired within the prior twelve
months as part of a business combination or asset acquisition under Rule
723(b). On a similar note, Rule 723(c) is a new exemption that permits
banks to exclude from the bank-wide calculation trust and fiduciary
accounts held at a "non-shell" foreign branch of a U.S. bank
so long as the bank has reasonable cause to believe that less than ten
percent of the total number of trust and fiduciary accounts of the
foreign branch are held by or for a U.S. person.

Under Rule 723(e), banks using the account-by-account method of
applying the chiefly compensated test may exclude a de minimis number of
accounts (no more than the greater of 500 accounts or one percent of the
bank's trust or fiduciary accounts) provided that no particular
account is excluded from the calculations under this de minimis
exception for two consecutive years. Last, under Rule 723(d), a bank
will not be deemed a broker solely because a particular trust or
fiduciary account does not satisfy the account-by-account chiefly
compensated test if the bank elects to transfer such account to a
broker-dealer or nonaffiliated entity that is not required to be a
broker-dealer within three months of the end of the year in which the
account fails to meet this standard.

Regulation R represents a significant step forward from proposed
Regulation B both in the broader definition of relationship compensation
under Rule 721 and the more flexible method of applying both the
bank-wide and the account-by-account chiefly compensated tests under
exemptive Rules 722 and 723. That being said, the trust and fiduciary
exception, as implemented by Regulation R, will likely impose a
significant burden on banks in maintaining appropriate records of their
application of the "chiefly compensated" test.

Under the sweep accounts push-out exception, (39) a bank may sweep
deposits into no-load money market mutual funds without being deemed a
broker. Rule 740 defines key terms used in the sweep accounts exception
such as "money market fund" and "no-load." A fund is
"no-load" if no sales load or deferred sales load is charged
by the fund and no more than twenty-five basis points are charged
against the fund's average net assets for sales or sales promotion
expenses, personal service, or the maintenance of shareholder accounts.
(40) Further, "money market fund" is defined under Rule 740(b)
as "an open-end company registered under the Investment Company Act
of 1940."

Rule 741 creates a general exemption for transactions in money
market mutual funds. A bank may rely on this exemption in two
situations. First, a bank will be exempt from the definition of broker
to the extent that it effects transactions on behalf of a customer in
securities of a money market mutual fund if the bank provides the
customer, directly or indirectly, with any other product or service that
does not require the bank to register as a broker-dealer, such as an
escrow, trust, fiduciary or custody account, a deposit account, or a
loan or other extension of credit. (41) Second, a bank may utilize this
exemption if it effects transactions on behalf of another bank as part
of a program for the investment or reinvestment of deposits held or
collected by the other bank. (42) Moreover, sweeping deposits into
"load" money market mutual funds is also an exempt transaction
provided that the bank discloses that the money market fund is not
"no load" and delivers a copy of the fund's prospectus to
the customer whenever the customer approves any transactions involving
securities of the fund. (43)

D. Safekeeping and Custody Activities Exception

The safekeeping and custody exception permits banks (44) to perform
specified services in connection with safekeeping and custody of
securities without being deemed to be a broker. (45) On its face, this
push-out exception does not address securities order-taking by custodial
banks, which the staff of the SEC has long viewed as a brokerage
function. Nevertheless, under the exemption in Rule 760, banks may take
orders for securities transactions (a) from employee benefit plan
accounts and individual retirement accounts for which the bank acts as a
directed trustee and similar accounts for which the bank acts as a
custodian, (46) and (b) from other safekeeping and custody accounts on
an accommodation basis (for ease of reference, "other
accounts"). (47)

If a bank accepts securities orders under this exemption with
respect to a custody account, no bank employee may receive compensation
from the bank, the executing broker or dealer, or any other person, that
is based on whether a securities transaction is executed for the
account, or on the quantity, price, or identity of the securities
purchased or sold by the account. These restrictions, however, do not
prevent a bank employee from receiving payments under a bonus plan that
would be permissible under the networking rules discussed above.
Further, a bank cannot advertise that it accepts orders for securities
transactions for employee benefit plan accounts or IRAs, except as part
of advertising the bank's overall custodial or safekeeping
services, and such accounts may not be advertised as "securities
brokerage accounts." (48) In addition, under Rule 760(e), a bank
acting as a non-fiduciary/non-custodial administrator or recordkeeper
for a plan for which another bank acts as custodian may accept
securities orders from such a plan without being considered a broker,
provided that both banks comply with the conditions explained above.

Additional conditions apply when a bank accepts securities orders
for "other accounts" on an accommodation basis under Rule
760(b). In particular, the bank will not be able to advertise its
securities order-taking services at all in public media. (49) It will be
permitted, however, to distribute sales literature to customers and
others describing the order-taking services provided to these accounts,
so long as the order-taking services are not described independently of,
or more prominently than, the bank's other custody services. (50)
Under Rule 760(b)(6), the bank will not be able to provide investment
advice or research or make recommendations concerning securities to the
account or otherwise solicit securities transactions from the account.
In addition, the amounts charged by the bank for effecting a securities
transaction for the account cannot vary based on whether the bank
accepted the order for the transaction, or on the quantity or price of
the securities to be bought or sold. (51) For example, the bank must
charge the same securities movement fee for transferring securities into
or out of the custody account regardless of whether the customer places
the securities order with the bank or a securities broker.

In response to comments on proposed Regulation R, the agencies have
added Rule 760(f), which extends the custody exemption to banks acting
as a sub-custodian for another custodial bank, under the same conditions
that the custodial bank must meet. The agencies also clarified that
banks may rely on the custody exemption when acting as a directed
trustee for an account, and that the restrictions in the custody
exception do not prohibit cross-marketing a bank's trust,
fiduciary, and other services to its custody customers.

E. Exemption for Certain Investment Company Securities Transactions

Section 3(a)(4)(C)(i) of the Exchange Act requires a bank to
execute the transactions that it effects under the push-out exceptions
for trust activities, stock purchase plan transactions, and safekeeping
and custody transactions through a registered broker-dealer, if the
transactions involve publicly traded securities. Rule 775(a)(3) provides
that, notwithstanding this statutory mandate, a bank may effect
transactions in "covered securities" either through the
National Securities Clearing Corporation (NSCC) or directly with a
transfer agent, an insurance company, or "separate account."
(52) As proposed, Rule 775(a)(3) defined "covered securities"
to include any securities issued by an open-end investment company. In
response to comments, the agencies expanded this definition to include
any variable insurance contracts, such as variable annuities or variable
life insurance that are funded by separate accounts and registered under
the Investment Company Act.

Thus, a bank will not need to direct trades in these covered
securities to a registered broker-dealer for execution provided that the
covered securities are not traded on a national securities exchange,
through the facilities of a national securities association, or through
an interdealer quotation system. (53) As a practical matter, this will,
among other things, allow banks to effect transactions in mutual fund
shares through NSCC Mutual Fund Services (Fund/SERV) and to effect
transactions in variable insurance contracts through NSCC Insurance
Processing Service.

F. Securities Lending Exemption

Rule 772 exempts banks from the definition of the term
"broker" for certain noncustodial securities lending
activities to the extent that they act as agents in effecting securities
lending transactions and provide any securities lending services in
connection with such transactions. The exemption only covers
transactions conducted on behalf of a "qualified investor."
(54)

Commenters on the proposed rules recommended that banks be exempt
from the definition of broker for effecting repurchase and reverse
purchase transactions in non-exempt securities, as these transactions
are functionally equivalent to securities lending transactions. In
response, the agencies have requested comments on various matters
relevant to their consideration of such transactions, including: the
nature, structure, and purpose of these transactions; the types of
customers and financial institutions currently involved in these
transactions; the extent to, and the manner in, which banks currently
engage in these transactions as agent or principal; recent developments
and trends in the market for these transactions; and any material
similarities and differences between, on the one hand, these
transactions and repurchase and reverse purchase transactions in exempt
securities and, on the other hand, securities lending transactions in
non-exempt securities. (55)

G. Regulation S Securities Exemption

Rule 771 provides an exemption for banks from the definition of
broker for agency transactions in Regulation S securities with non-U.S.
persons. The exemption covers both sales of eligible securities to a
purchaser located outside of the United States and resales of eligible
securities after their initial sale by a non-U.S. person or a registered
broker-dealer outside the United States to a purchaser who is also
outside the United States. Thus, a bank is not considered a broker when
it effects transactions involving Regulation S securities, so long as it
complies with Regulation S and does not conduct the transaction with any
U.S. person other than a registered broker-dealer.

H. New Exemption for Effecting Certain Excepted or Exempted
Transactions in a Company's Securities for Its Employee Benefit
Plans

Rule 776 is a new exemption from the definition of broker for
transactions in a company's securities for such company's
employee benefit plan(s). It allows a bank to buy or sell, as transfer
agent, securities of a company for the account of the company's
employees as part of a pension, profit-sharing, bonus, dividend
reinvestment, or issuer purchase plan. A bank must satisfy four
conditions in order to be able to rely on this exemption. First, no
commission may be charged with respect to the transaction. (56) Second,
the transaction must be conducted solely for the benefit of an employee
benefit plan. (57) Third, the security must be obtained directly from
the company or an employee benefit plan of the company. (58) Fourth, the
security must be transferred only to the company or an employee benefit
plan of that company. (59)

I. Transition Period Exemption

Regulation R also provides banks with a temporary exemption under
Rule 781 by extending the compliance date for the regulation until the
first day of each bank's respective first fiscal year commencing
after September 30, 2008. For example, a bank with a fiscal year that
runs from January 1 to December 31 would have until January 1, 2009, to
comply with the new exemptions. This period should provide banks with
sufficient time to push out of the bank any brokerage activities that
will not qualify for an exception or exemption.

J. Next Steps by the SEC and the Banking Agencies

As noted in the Adopting Release, the FRB and other banking
agencies, in consultation with the SEC, will develop recordkeeping
rules, which they will propose for public comment. (60) The FRB and
other banking agencies also expect to develop supervisory guidance to
help ensure that banks have adequate policies, procedures, and systems
in place to conduct their securities brokerage activities in a safe and
sound manner and to help prevent evasions of GLBA's broker push-out
exceptions and implementing rules. Finally, going forward, the FRB and
the SEC will jointly issue any interpretations or "no-action"
letters relating to the bank brokerage exemptions and will consult with
each other and any other appropriate federal banking agency concerning
any formal enforcement actions that are proposed to be taken against
individual banks. As of the date of submission of this Article for
publication, there have been no further rule-making or interpretive
actions taken by the FRB and/or the SEC. Thus, banks must play the
"wait and see" game.

III. CHANGES TO THE DEALER RULES

The SEC also adopted a number of mostly clarifying and technical
amendments to its rules relating to the exemptions for banks from the
definition of "dealer." (61) Notably, these dealer rules
include some exemptions from the definition of dealer that parallel
certain exemptions provided from the definition of broker. Exchange Act
Rule 3a5-2 exempts from the definition of dealer a bank's riskless
principal transactions in "eligible securities" conducted with
non-U.S. persons pursuant to Regulation S. "Eligible
securities" are securities that are neither in the inventory of the
bank or an affiliate nor underwritten by the bank or an affiliate on a
firm commitment basis. (62) For the purposes of determining whether an
eligible security was initially sold outside of the United States as
required by Regulation S, a bank may rely on its "reasonable
belief" that this condition is satisfied. (63) The 3a5-2 exception
also extends to resales of the eligible securities, provided that the
bank complies with Regulation S.

The SEC also re-designated the bank/dealer exemption for conduit
securities lending activities from Exchange Act Rule 15a-11 to Exchange
Act Rule 3a5-3 as of November 2, 2007. (64) The exemption allows banks
to conduct conduit securities lending transactions with a qualified
investor or an employee benefit plan with discretionary investments of
at least $25 million, without registering with the SEC as a dealer. (65)

IV. AMENDMENTS TO EXCHANGE ACT RULE 15A-6

The SEC also amended Exchange Act Rule 15a-6 to align the language
of that rule with the exceptions and exemptions for banks from the
definitions of broker and dealer under the Exchange Act. Revised Rule
15a-6(a)(4)(i) clarifies that a non-U.S. broker may, without registering
with the SEC, engage in a securities transaction with a U.S. bank to the
extent that the bank is relying on "an exception or exemption from
the definition of 'broker' or 'dealer' in sections
3(a)(4)(B), 3(a)(4)(E), or 3(a)(5)(C) of the [Exchange] Act or the rules
thereunder" (citations omitted). (66) This wording replaces the
"bank acting in a broker or dealer capacity" language from the
previous version of the Rule. (67) This amendment, however, is not
intended to substantively change the rule. Thus, foreign broker-dealers
will be exempt from registration with the SEC so long as the U.S. banks
(or U.S. branches and agencies of foreign banks) acting as their
counterparties rely on an exception or exemption under Regulation R or
the dealer push-out rules. (68)

V. CONCLUDING OBSERVATIONS

Viewed in the context of the SEC's prior efforts to regulate
bank securities activities, Regulation R is a significant improvement
over prior SEC efforts in this area, from the perspective of reducing
disruption to bank operations and customer relationships. The
congressional mandate in the Regulatory Relief Act, that the SEC and the
banking agencies reach concordance on the regulation of bank securities
activities, has led to a relatively successful outcome. Notwithstanding
its achievements, the final product falls short in some areas. For
example, the networking exception does not adequately accommodate
current bank bonus plans, as most of these plans are based on
transaction revenues rather than overall profitability. Accordingly,
most banks will be required to substantially restructure their bonus
plans in order to comply with Regulation R. In addition, the trust and
fiduciary exception will impose a significant recordkeeping burden on
banks in applying the "chiefly compensated" test with the
exact recordkeeping requirements yet to be drafted by the banking
agencies.

Finally, although there has not yet been any formal or informal
follow-up rulemaking or interpretive actions by the SEC and FRB, this
may be the calm before the storm. There may be a flurry of activity at
or near the end of September 2008 (before the Regulation R compliance
date). Accordingly, banks that wish to seek guidance from these agencies
would be wise to consider approaching the regulators sooner rather than
later. Indeed, it would be prudent for banks to examine carefully their
securities activities in advance of the Regulation R compliance date.

(3.) The Securities Exchange Act of 1934 defines "bank"
in Section 3(a)(6) as: (A) a banking institution organized under the
laws of the United States or a federal savings association, (B) a member
bank of the Federal Reserve System, (C) any other banking institution or
savings association, whether incorporated or not, doing business under
the laws of any State or of the United States, a substantial portion of
the business of which consists of receiving deposits or exercising
fiduciary powers similar to those permitted to national banks under the
authority of the Comptroller of the Currency pursuant to section 92a of
Title 12, and which is supervised and examined by State or Federal
authority having supervision over banks or savings associations, and
which is not operated for the purpose of evading the provisions of this
title, and (D) a receiver, conservator, or other liquidating agent of
any institution or firm included in clauses (A), (B), or (C) of this
paragraph. Securities Exchange Act of 1934, 15 U.S.C. [section]
78c(a)(6) (2000).

(4.) See id. [section] 78c(a)(4) (Section 3(a)(4)); see also
Section 3(a)(5) of the Exchange Act, which defines "dealer."
[section] 78c(a)(5). The SEC also issued a companion release making
certain conforming and technical amendments to its existing rules
relating to the bank exceptions from the definition of
"dealer" under the Exchange Act. See Exchange Act Release No.
56,502 (Sept. 24, 2007), 72 Fed. Reg. 56,562 (Oct. 3, 2007) (hereinafter
the "Dealer Rules Release").

(5.) See Exchange Act Release No. 47,364 (Feb. 14, 2003), 68 Fed.
Reg. 8,686 (Feb. 24, 2003). In contrast to Regulation R, the bank dealer
rules were not adopted as part of a unified regulation, but rather are
interspersed under various sections of the Exchange Act and designated
accordingly.

(15.) Regulation R, however, does not provide further guidance with
respect to all of the statutory push-out exceptions available to banks
from the definition of broker because commenters did not generally seek
further guidance on those exceptions. In particular, Regulation R does
not interpret the push-out exceptions for: effecting transactions in,
among other things, commercial paper, bankers acceptances, and exempted
securities under Exchange Act Section 3(a)(4)(B)(iii); effecting
transactions, as part of transfer agency activities, in the securities
of an issuer as part of certain stock purchase plans under Exchange Act
Section 3(a)(4)(B)(iv); effecting transactions for the account of
affiliates (other than registered broker-dealers or merchant banks)
under Exchange Act Section 3(a)(4)(B)(vi); effecting sales as part of a
primary offering of securities not involving a public offering under
Exchange Act Section 3(a)(4)(B)(vii); effecting transactions in
identified banking products under Exchange Act Section 3(a)(4)(B)(ix);
effecting transactions in municipal securities under Exchange Act
Section 3(a)(4)(B)(x); and the de minimis exception that permits no more
than 500 securities transactions in any calendar year under Exchange Act
Section 3(a)(4)(B)(xi). 15 U.S.C. [section] 78c(a)(4)(B) (2000).

(16.) Section 29 of the Exchange Act provides that contracts made
in violation of any provision of the Exchange Act or the implementing
regulations of the Exchange Act are generally void with regard to the
rights of any person who has made, or with knowledge of such violation
acquired any rights under, such contract. 15 U.S.C. [section] 78c(c)
(2000).

(25.) Id. In the Adopting Release, the agencies state that a bank
or broker-dealer would have a "reasonable basis to believe"
that a customer is a high net worth customer or institutional customer
if, for example, the bank or broker-dealer obtains a signed
acknowledgment from the customer (or, in the case of an institutional
customer, from an appropriate representative of the customer) that the
customer meets the applicable standards to be considered a high net
worth customer or an institutional customer, respectively, and the bank
employee making the referral or the broker-dealer employee dealing with
the referred customer does not have information that will cause the
employee to believe the information provided by the customer is false.
Adopting Release, supra note 2, at 56,525.

(26.) Rule 701(d)(4)(ii).

(27.) Rule 701(d)(4)(i).

(28.) Rule 701(a)(3)(ii)(A).

(29.) Rule 701(a)(3)(iii)(B).

(30.) To the extent that bank employees are qualified and act in
their capacity as registered persons of a broker-dealer
("dual" employees), and therefore are subject to the
supervision of such broker-dealer, the bank does not need to rely on the
networking exception for paying these employees an incentive fee for
referring bank customers to a broker-dealer. In the new rules, the SEC
and FRB did not address the applicability of the Financial Industry
Regulatory Authority (FINRA) rules governing private securities
transactions of FINRA member employees (so-called "trading
away" rules) to the dual employees. The release notes that the
agencies expect to continue to work on this issue with FINRA, although
the authors are aware of no progress on this point as of the date of
submission of this Article.

(31.) Section 3(a)(39)(E) of the Exchange Act refers to a person
who is statutorily disqualified for having "associated with him any
person who is known, or in the exercise of reasonable care should be
known, to him to be a person" disqualified under subparagraph
(A)-(D) of section 3(a)(39). 15 U.S.C. [section] 78c(a)(39)(e) (2000).

(38.) Id. The types of fees that are counted toward relationship
compensation are much broader than those proposed in SEC releases
predating Regulation R. For example, under the 2004 Regulation B
proposal, 12b-1 fees would have counted as transaction fees that are not
includable in relationship compensation, whereas under Regulation R they
are part of relationship compensation.

(40.) Rule 740(c)(1). Certain enumerated shareholder and other
service charges are excluded from the twenty-five basis point limit.

(41.) Rule 741(a)(1)(A).

(42.) Rule 741(a)(1)(B).

(43.) Rule 741(a)(2)(ii).

(44.) After the agencies adopted Regulation R, the Institute of
International Bankers (IIB) requested from the SEC an exemptive order,
which would provide that a foreign bank that does not fit within the
definition of "bank" under Section 3(a)(6) of the Exchange
Act, but qualifies as a "comprehensive consolidated
supervision" bank (CCS Bank) as defined in 12 C.F.R. [section]
211.24(c), may act outside United States as securities custodians for
U.S. investors with respect to both U.S. and non-U.S, securities without
registering as brokers or dealers. The IIB has specifically requested
that CCS Banks be permitted to provide U.S. investors the same type of
safekeeping, custody and order-taking services as are otherwise
permissible for banks (as defined in Section 3(a)(6) of the Exchange
Act) under Regulation R. As of the date of submission of this article
for publication, the SEC has not taken any apparent action on this
request from the IIB.

(45.) Securities Exchange Act of 1934, [section] 78c(a)(4)(B)(viii)
(Section 3(a)(4(B)(viii)). A bank may only rely on this exception if it
does not act in a trustee or fiduciary capacity, and complies with the
SEC's guidance regarding carrying broker activities. In response to
various comments pointing out the lack of guidance in the Regulation R
proposal about the prohibition on acting as carrying broker, the
Adopting Release provides that a bank would be acting as a
"carrying broker" for a broker-dealer if the broker-dealer has
established arrangements with the bank that cause the
broker-dealer's customers generally to use the bank's custody
accounts instead of maintaining funds and securities in accounts at the
broker-dealer, thereby allowing the broker-dealer to avoid its financial
and related responsibilities under SEC rules. See Adopting Release,
supra note 2, at 56,540.

(46.) Rule 760(a). For this purpose, Rule 760(h)(5) defines broadly
employee benefit plan accounts to include a wide range of tax advantaged
accounts, including: a 401(a) employer-sponsored plan; a 457
governmental or other plan; a 403(b) tax-deferred plan; a church plan,
governmental, multiemployer or other plan described in section 414(d),
(e) or (f) of the Internal Revenue Code (IRC); a 422 incentive stock
option plan; a Voluntary Employee Beneficiary Association Plan under
Section 501(c)(9) of the IRC; a non-qualified deferred compensation plan
(including a rabbi or secular trust); and a supplemental or mirror plan,
and a supplemental unemployment benefit plan. "Individual
retirement account" or similar account means an individual
retirement account as defined in Section 408 of the IRC; a Roth IRA; a
health savings account; an Archer medical savings account; a Coverdell
education savings account; or other similar account.

(47.) Rule 760(b).

(48.) Rule 760(a)(2).

(49.) Rule 760(b)(4).

(50.) Rule 760(b)(5)(ii).

(51.) Rule 760(c).

(52.) "Separate account" means an account established and
maintained by an insurance company under which income, gains, and losses
from assets allocated to such account are credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company. See Investment Company Act of 1940 (Investment
Company Act), 15 U.S.C. [section] 80a-2(a)(37) (2000) (Section
2(a)(37)). Under Rule 775(b)(1)(ii), a separate account must be
registered under the Investment Company Act, and excluded from the
definition of transfer agent in section 3(a)(25) of the Exchange Act.

(53.) In addition, the covered securities have to be underwritten
by a registered broker-dealer or the sales charge has to be equal to or
less than the amount a registered broker-dealer may charge pursuant to
the rules of FINRA.

(54.) Section 3(a)(54)(A) of the Exchange Act defines a qualified
investor generally as financial institutions or entities with $25
million of investments to invest on a discretionary basis, or an
employee benefit plan that owns and invests on a discretionary basis, at
least $25 million in investments. 15 U.S.C. [section] 78c(a)(54)(A)
(2000) (Section 3(a)(54)(A)).

(55.) As of the date of submission of this Article for publication,
there have been no comments submitted to the agencies in response to
this request.

(56.) Rule 776(a)(1).

(57.) Rule 776(a)(2).

(58.) Rule 776(a)(3).

(59.) Rule 776(a)(4).

(60.) Adopting Release, supra note 2, at 56,516.

(61.) See Dealer Rules Release, supra note 4.

(62.) Exchange Act Rule 3a5-2(b)(2).

(63.) Exchange Act Rule 3a5-2(a)(3).

(64.) Exchange Act Rule 15a-11 also provided an exemption to banks
from the definition of broker for banks with respect to their securities
lending activities. The Regulatory Relief Act, however, voided this
exemption, and the SEC and the FRB have adopted substantively identical
provisions in Regulation R Rule 772.

(65.) Commenters asked the agencies to exempt banks from the
definition of dealer for repurchase and reverse purchase securities
transactions, as these transactions are functionally equivalent to
securities lending. Although the agencies have not taken any action on
this request, they are asking for comments on various aspects of
repurchase and reverse purchase transactions.

(66.) Exchange Act Rule 15a-6(a)(4)(i).

(67.) 17 C.F.R. [section] 240.15a-6(a)(4)(i) (2007).

(68.) The effective date of the amendment to Rule 15a-6 was
November 2, 2007, while compliance with substantive provisions of
Regulation R will not begin until after September 30, 2008. Until that
date, however, a foreign bank will be exempt from registration as a
broker-dealer to the extent that its counterparty U.S. bank is relying
on the temporary exemption under Rule 781 of Regulation R.

JEROME J. ROCHE AND BABBACK SABAHI, Mr. Roche is a partner and Mr.
Sabahi is an associate with the law firm of Mayer Brown LLP. The authors
wish to acknowledge the generous assistance of a number of current and
former colleagues--Charles Horn, David Sahr, Scott Anenberg, Ross
Pazzol, Arthur Laby, Michael Allemeier and Shahriar Hafizi--without whom
this article would not and could not have been written. This Article is
intended only for general information purposes, not for legal advice.

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